Fixed income is widely seen as a major growth frontier for the exchange-traded funds (ETFs) industry, and the data suggest that this thesis is being proven with conviction. On a global basis, bond ETFs topped $800 billion in combined assets under management for the first time last week, according to data from BlackRock, Inc. (BLK). BlackRock is the parent company of iShares, the world's largest ETF issuer.
"Investors navigated uncertain markets using bond ETFs to implement active portfolio decisions – positioning for rising rates and spread volatility using short duration, floating rate and hedged products," said BlackRock. (See also: Bond ETFs: A Viable Alternative.)
Last year, the Federal Reserve boosted interest rates three times, but bond investors widely embraced ETFs. For example, the iShares Core U.S. Aggregate Bond ETF (AGG) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), the largest corporate bond ETF, took in about $21.8 billion in new assets on a combined basis. AGG and LQD were seventh and eighth, respectively, in terms of assets added among U.S.-listed ETFs last year.
Pivotal to the growth of bond ETFs is increased advisor education and dispelling myths. For example, some investors may believe that corporate bond ETFs are heavily allocated to the most indebted issuers, but in reality, funds like LQD are usually heavily allocated to large, well-known, financially sound companies.
"In fact, many of the companies held by fixed income indexes are very familiar to equity investors," said BlackRock. "For example, nine of the top 10 issuers in the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) are also in the S&P 500, with only Anheuser-Busch Inbev not included because it is not a U.S.-listed equity security. All ten of the top issuers have greater than $100 billion in equity market capitalization." (For more, see: Top 3 Investment-Grade Corporate Bond ETFs.)
Another frequently cited myth is that bond ETFs incur high turnover rates and transaction costs to stay in line with the underlying index. That is not the case. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the largest junk bond ETF, had a turnover rate of 13% for the fiscal year ended Feb. 28, 2017, according to BlackRock. By comparison, the "average annual turnover among actively managed strategies in the Morningstar U.S. High Yield Bond Fund Category was 82%," said BlackRock.
Although the Fed has already raised rates once this year, with some bond market observers forecasting as many as three more rate hikes through 2018, investors are still embracing bond ETFs, including shorter duration fare. The iShares Short Treasury Bond ETF (SHV) has seen year-to-date inflows of $5.29 billion, a total surpassed by just two other ETFs. SHV has an effective duration of just 0.37 years. (See also: The Time for Short Duration Bonds Is Now.)